President of XM Satellite Radio Discusses Business Strategy

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• TERENCE SMITH:

  For somebody who doesn't have, and maybe hasn't even seen or heard XM Satellite Radio, describe it. What is it?

• HUGH PANERO:

  Well, XM Satellite Radio is sort of the ultimate radio service.

  What we do is we deliver over 130 channels of commercial-free music, we have about 68 channels of that, we have news, talk and sports and entertainment. We have sports like Major League Baseball. We have Bob Edwards.

  And what we do is we deliver it up to a satellite and it's received by a tiny little antenna on your car and many of the devices that we have will receive the signal, will display what channel you're on, what the artist is that you're listening to, with the name of the song, as if that's what's happening and then you can actually take this device in many cases from your car to your home, and with a device we just released, you can actually wear it on your belt.

  And it costs $10 a month and it really is — you know, there was AM, there was FM, and now there's, you know, XM, which is the next generation of radio.

• TERENCE SMITH:

  What's been the response of the people that have (it) so far? And, how many subscribers?

• HUGH PANERO:

  Well, 3.2 million people are XM subscribers as of the end of 2004.

• TERENCE SMITH:

  And when you project this in your mind as a business, what do you expect by the end of 2005? And where do you get to the point of viability?

• HUGH PANERO:

  Well, we believe we reach cashflow — break even — in 2006. We think that we will have in excess of 20 million subscribers by 2010. We think this is an absolutely enormous market, even bigger than what the analysts have projected.

  There's over 230 million licensed vehicles on the road, there's 140 million or so households.

  You basically have people that, you know, want access to the kinds of things that we offer, that they can't get because local radio really doesn't deliver it.

  They don't deliver digital quality. It can't be heard nationally across, going from New York to California, and we basically are delivering the passion of music that's sort of been lost in radio.

• TERENCE SMITH:

  I mean, that of course would be the first question I think in any consumer's mind is — why should I pay for something that has traditionally been free?

• HUGH PANERO:

  Well, it's funny that you mention that, because when we were a PowerPoint presentation before we became the product of the year — that was the basic question, the first one that people asked is, Why would people pay for radio?

  And I grew up in the cable television industry where, in the early days of my nascent career, the big question was why would people ever pay for TV, and which it clearly, you know, 70, 80, 90 million people do.

  And it really is about just delivering quality content.

  And clearly, having 22 minutes of commercials on a local radio station — mostly talk, very little music and not the music you want to hear in many cases because it can't be supported by the economic model of a radio station — has basically drawn people to other alternative forms of getting content they want, whether it be satellite radio, whether it be, you know, iPod, whether it be the Internet, and we're just part of the revolution that's going on to satisfy the needs of people who want content when they want it in a very convenient way.

• TERENCE SMITH:

  How many subscribers do you need to make money?

• HUGH PANERO:

  We really don't really talk about that because there are many levers that you push in terms of how many subscribers you get from different distribution sources, whether they come from people walking into a store and buying the radio or from the car market.

  But right now we believe that we'll have 20 million subscribers by 2010.

  The makeup of those subscribers right now are about 50 percent of people who see our advertising and walk in and buy a device at a Circuit City, a Best Buy or a Wal-Mart.

  And another 50 percent of the people who actually are buying a new car that has XM factory-installed, where we preview the service for several months, and at the end of this trial period six out of ten people subscribe to the service through, you know, companies like General Motors and Honda. And we recently signed a deal with Toyota, who will be in factories, installing XM radio in their cars in 2006.

• TERENCE SMITH:

  So how many cars will come off the assembly lines this year with, with satellite radio, yours or the competition?

• HUGH PANERO:

  Well, speaking for XM, GM, in December of '04, hit a milestone of 1 million XM customers who are GM car owners.

  And GM and Honda combined, for the 2005 calendar year, are going to produce 1.5 million cars that are factory-installed with XM Satellite Radio. And we, by far, have been the leader in both the retail market and the OEM [Original Equipment Manufacturing] market — or the new car market, you know, without the acronym — and we continue to maintain that lead and grow it as we have taken this business from its very early stages of it being a PowerPoint presentation to where we are today, which has been very exciting.

• TERENCE SMITH:

  Is there room for two of these services in the marketplace?

• HUGH PANERO:

  I think there is. It's a big market. Clearly, we are competing not only against our duopoly competitor but, clearly, there are other forms of entertainment and distraction that people have in the car.

  But I think that both companies can be successful. I think it's all about execution and I think that how we've been evaluated on Wall Street, and our management team has been at — with very high marks in terms of executing and actually having been, in the beginning, the underdog and then kind of zipped past the competitor because of our technology lead and our ability to execute getting XM into the big car companies.

• TERENCE SMITH:

  Beyond the technology, what are you selling here? Are you selling a different lifestyle, a different approach? Metaphorically, what are you offering people?

• HUGH PANERO:

  Well, I think what we're offering people is this ultimate audio form of entertainment. I mean, there's many people who would — will love to spend hours at night searching for music and downloading it, and buying it at iTunes, and all of that, and that's fine — there's young people that do that every day.

  But in my lifetime, I don't have two hours to spend. I'm reading a book to my son or my daughter, and I think, like cable television or satellite television, there's a large group of people who basically want somebody to be the concierge service, to provide them with information and what we do is we provide news feeds from the BBC and Fox News and CNN and the Bob Edwards show.

  And on the music side, we can help people navigate through the new music because they trust us. They believe that we love the music, we love the blues, we love classical music. If you're a sports fan, we're going to have Major League Baseball starting in two — starting in the spring with pitchers and catchers.

  And so I think that for those people whose lifestyles change, we fill a void that has been created because local radio abandoned them, and for those people whose lifestyles will get busy, we are able to provide something —

• TERENCE SMITH:

  Could you pick up the thought, on the lifestyle issue?

• HUGH PANERO:

  Well, I think that what XM provides is an alternative to the way people have received audio entertainment in the past, and as a lifestyle issue, you have those people who are very focused on owning, downloading, you know, buying, purchasing, and spending hours searching on the Internet.

  There's another group of people who simply want to pay their ten bucks a month, trust a company like XM, who believes in the blues and classical music, and provides Major League Baseball and Bob Edwards, and news feeds, 130 channels, along with traffic information, and I can trust those people like a concierge, to direct me to places where I can learn about music, explore it, and maybe go buy an album on the Web, and we become an enormous muse for consumers who are driving in their car, walking on the street, you know, listening to it at home.

• TERENCE SMITH:

  In the competition between XM and Sirius radio, is, is content the king? Is content going to decide it? Technology? Some combination?

• HUGH PANERO:

  Some combination. On the content side, you know, Billboard magazine named us radio service of the year. So on the content side, we're — 'I think winning.' I think that that's a constantly-shifting creature.

  You got to get better, you've got to get better if you're in public broadcasting or in commercial television or in the movie business.

  We have to improve. We basically have a series called Artist Confidential, very much like behind the Actors Studio, where people like Bob Weir or Bonny Raitt or Neal Sedaka, or great artists, Phil Collins, come in. We have interview shows where we talk to them intimately and then they play music. Very unique to radio.

  Radio used to be — local radio used to be a live medium. Everything's taped, done from another part of the country, really not much localism to local radio.

  And we deliver these kinds of things, and then each of our DJs don't program the stations based on some script that they've been given about what Billboard saw and happens to be the highest rotation or maybe some influence that they have from a record company.

  They do it based on their own knowledge and passion for the music, which is very unique, and I think people migrate to that kind of creativity.

• TERENCE SMITH:

  Now your competition has responded to the challenge, and maybe the lead that you established early on, and spent a very large bundle of money to hire Howard Stern.

• HUGH PANERO:

  Yes, they did.

• TERENCE SMITH:

  A serious challenge.

• HUGH PANERO:

  Yes. Well, a serious challenge in one particular genre. I mean, they basically paid half a billion dollars to hire Howard Stern. It's like $100 million a year.

  And, clearly, it was a terrific deal for Howard Stern. Whether it makes good economic sense is to be seen, and, clearly, Howard Stern has a certain audience that he's very attracted to. His actually ratings have been going down of late, based on the local radio ratings that come out, and he has as many negatives that go with his positives.

  So the question always is, from a business standpoint, you know, is there a return on that investment and do you really think that there's going to be Howard Sterns' picture at the Ford Motor dealership in the Midwest where they're trying to sell satellite radio? I'm really not quite sure.

  But we all make our bets. I mean, we basically believe that an investment, which we made a significant investment in Major League Baseball. We think it's the crown jewel of sports content. There's 2,400 games. It's available at different times of the day. You basically have a sport — you know, people like, you know, that were sort of made for radio, for those people who understand the evolution of different mediums, and we're very excited about that, and it's something that the whole country can enjoy and I think that's the kind of investment that we made.

• TERENCE SMITH:

  Was baseball your response to Howard Stern?

• HUGH PANERO:

  Baseball was something that we had always wanted to do. The problem was that some of the rights were really tied up, you know, at the time with ESPN for a number of years, and when they became available, we basically went and got the deal because we — in speaking to consumers and car companies and retailers — baseball made the most sense, compared to something like football which is, you know, 18 weeks out of a year.

  If you really want to watch or experience a football game, you really watch it on television, and it's on Sunday, so it's not exactly a high-driving time.

  But with something like baseball, every day there's a baseball game and actually at different times of the day. So we can basically go after the "dislocated fan." It's the Dodger fan that lives in New York, or the Yankee fan that lives in the Midwest and these people are fanatical about their teams, as evident by what happened during the Yankee/Red Sox series, where an entire country was energized by what was going on.

• TERENCE SMITH:

  Sirius has Howard Stern. You have Opie and Anthony. And you're not under FCC regulation. Is satellite radio sort of going "down market" and going to edgy programming?

• HUGH PANERO:

  I think we have edgy programming, because I think there's a place for coarse comedy in an environment where people are electing to, you know, pay maybe a $100 for radio and then $10 a month, and then we have the ability to block out the channels.

  But in terms of our channel lineup and our economic commitment, there's a different between having a service like Sirius that has committed half a billion dollars to Howard Stern, who's actually going to program three channels, and to our commitment to have a show for Opie and Anthony that has an hour or two to exploit what is his, you know, humor, and in the marketplace.

  So I think that there are abilities for us to have more speech freedom because of this.

  But it also comes with more technology that allows people not to get it if you don't want it, to block it out, but very different than local radio where you can't prevent anybody from hearing coarse language, and also the radio stations, as you know, were given these frequencies and paid nothing for them, and therefore they are held to a higher standard of regulation with regards to protecting people from what might be controversial speech because you can't protect it.

  Clearly with a subscription service it's a different model.

• TERENCE SMITH:

  Is there a line that you don't want to cross?

• HUGH PANERO:

  I think that there's a certain line that exists, you know, and I think that we have a sensitivity to what that line is. I sort of — you sort of know it when you see it, I guess is the expression.

  But clearly, we — I think what's happening is that even some people like Opie and Anthony, who've been controversial on local radio, are sort of maturing through the process and learning that, you know, they want to evolve as either comedians or entertainers and that the humor that may have worked in an open-air environment, let's say on local radio, they have to be a little more sophisticated maybe in our medium but still be cutting edge and be controversial.

  I think that that's what a magazine rack of speech is all about. And so you have — we range from Bob Edwards, actually, who launched on the same day as Opie and Anthony, and Bob Edwards, a voice that was about to be cut off on local radio and we preserved that voice.

  So it is a balance that occurs in our channel lineup and our programming decisions.

• TERENCE SMITH:

  I guess I'm wondering if you have in your head some definition of something that you would find too offensive to put on the air.

• HUGH PANERO:

  I think we do and we have broadcast standards, and I think there is obviously laws and legislation that's out there in terms of certain restrictions that even exist, that supersede issues of what the FCC is, and I think that we're conscious of what those things are and what we think is tasteful or just being aggressive.

  But we obviously weigh it on the side of speech and the fact that there's 130 channels and if you don't want to listen to that channel, just go to 129 other channels and don't subscribe, or block it out or get a radio.

• TERENCE SMITH:

  Would it be damaging, in your view, to satellite radio as a medium to be seen as smut radio?

• HUGH PANERO:

  I think that's a situation that really can't exist. I think maybe in the case of Sirius because they made such an enormous investment in Howard Stern, but our channel lineup is much more balanced, and we have 68 commercial-free music channels, we have 21 traffic and weather channels, we have five or six news channels like Fox and CNN.

  We have talk channels that feature Sean Hannity and a number of talk personalities.

  So if you just look on a percentage basis, it's a small amount of our channels that have what is controversial speech from what we call these kinds of jocks compared to the wealth of programming that we offer, you know, to clearly outweigh it and balance it out.

• TERENCE SMITH:

  Uh-huh. What about political slant? I see you're adding Dr. Laura and G. Gordon Liddy. Do I sense a little drift to the right here?

• HUGH PANERO:

  No, we have various channels, America Left and America Right. We were one of the first radio outlets to actually find a home for Al Franken and Air America, and what we're really just looking at is who are proven radio talk personalities that like this platform and — three years ago wouldn't talk to us, but now say this is a great way to reach, you know, their message.

  So, we have this America Left platform that has Al Franken and Air America and Randi Rhodes, which I'm sure you've done stories on or you understand who they are.

  And then we have a series of the 'Sean Hannitys' of the world and 'Dr. Lauras,' and so on, who maybe talk to a different audience, but each one of them has a large following and it's really up to the listener to decide what is the niche of programming that they want to listen to.

• TERENCE SMITH:

  Is it important to you not to get labeled one way or the other?

• HUGH PANERO:

  I don't really think about it much. I don't think we have an issue of being labeled each way. I think what we're really focused on is that we just have 130 niches that we want to exploit and some of them are far left, far right — traffic, weather, classical, blues, and as long as we're satisfying a lot of niches I'm pretty happy.

• TERENCE SMITH:

  Is there — you're not now under the control of the FCC. But there is great resentment on the part of terrestrial radio about that, and various legislative moves.

  Do you seriously anticipate any change in that?

• HUGH PANERO:

  Well, I think there'll be a lot of debate and I think that the work of Congress is to create debate and discuss issues.

  I think that much of the local radio banter on this issue is — doesn't have much credibility. I mean, this is a local radio that has not fulfilled some of its commitments to go digital. They basically say they're local but they bring in signals from outside the market. They've just added more commercials.

  They are an organization that really isn't that focused on improving their own product but basically participating in what might be considered anticompetitive tactics to hurt the new guy on the block, which is what they've been doing for a number of years.

  I mean, for example, there was a fight among the broadcasters which was sort of rejected by the FCC to say we don't want satellite radio providing any a these local traffic and weather channels.

• TERENCE SMITH:

  Uh-huh. How significant would it be to you if you came under greater federal regulation than you presently have?

• HUGH PANERO:

  Well, I don't really, you know, deal in hypotheticals. I think that what we are is a subscription service and the regulations and and case law is pretty clear about certain speech issues. So we have a service where you buy a piece of equipment and you pay a subscription, you can block out channels you don't want, and we don't fall under the same regulation or supervision that a radio company who basically got the airwaves for free, and anything that goes on the airwaves can be heard by anybody in the car, without them making some decision other than to turn on and off the radio, and I think when you're choosing what business you want to go into, you've chosen that business, you've exploited it for a number of years, and we're just a different form. We're much more like cable television or satellite television.

• TERENCE SMITH:

  Remind me. When did you go on the air?

• HUGH PANERO:

  We went on the air in 2001.

• TERENCE SMITH:

  Oh, that's right. It was supposed to be September 11th, was it?

• HUGH PANERO:

  Right. We were supposed go on on September 12th and we were obviously impacted, dramatically, as the whole world was, by what happened on September 11th.

• TERENCE SMITH:

  So when did you — how quickly did you —

• HUGH PANERO:

  We basically launched about 30 days later, later in September, and we launched, but, you know, clearly, things that happen in your lives, both professional and personal, put all the success in perspective. So we pulled our advertising, you know, on September 11th in markets, and we kind a moved on and then launched it about a month later and, you know, the first subscriber was a very exciting moment. But so is 3.2 million subscribers, and the 5.5 million that we expect at the end of this year.

• TERENCE SMITH:

  So that's three and a half years, basically that you've been on the air.

• HUGH PANERO:

  Uh-huh.

• TERENCE SMITH:

  Look ahead to the next three and a half years or five years for satellite radio, you and the competition. What do you see? A continuing competitive situation for subscribers and attention?

• HUGH PANERO:

  Yes. I see a typical, let's say, duopoly market between these two competitors, but, clearly, you know, competing against many other things that people experience in the car.

  As I said, I think as a company XM will be about 20 million subscribers in a competition head to head with the other company. I like duopoly competition where I'm the leader and they have less market share, which I think we've sort of established.

  But I see us not just being a satellite radio company per se, but actually being a content distributor that is using our creativity to have our service available wherever people can listen to audio.

  So whether it be on a telephone or over the Internet, or in what other kind a devices are going to happen over the next ten years, I want to be there because we don't want to be put in some corner of just being a "satellite radio company" and I think we're in the middle of original creation.

  We have very creative marketing partnerships with, you know, many different companies that are, range from Major League Baseball to Starbucks to production companies. We want to be a very vital part of the whole audio world.

• TERENCE SMITH:

  Do you see satellite radio providing video images at some point?

• HUGH PANERO:

  Yeah, we have demonstrated the ability to do video in the car, and we think that there is a technology that can satisfy that from a technology standpoint. The issue that we basically are working up from a business standpoint is whenever you do video it takes up a lot more bandwidth than audio.

  So what are you willing to sacrifice by doing one or two or three channels of video? What's the economic model that supports that and what are you willing to give up to do that?

  And how does that play in the face of a car market where there is a lot of high-end SUVs and cars that have built-in video systems but people who also have, you know, CDs and, and a number of portable games they — game, and video stations that are coming out every day. Is there a model that works so that, you know, our business works with that as a component of it? And we are constantly exploring that.

• TERENCE SMITH:

  What about text and data, and if so, what kind?

• HUGH PANERO:

  Well, we've been leading in the text and data. We actually have exclusive data services agreement with companies like General Motors and Honda and Toyota, and just recently Nissan, where we have actually begun to exploit that already.

  We have a service called XM Nav Traffic which is a partnership between Acura Link, Acura's car band and NavTech and a number of other information providers. And what we do is where you have a GPS system, where you can plug in where you are and where you want to go and it shows you a route, we actually have found a way to superimpose traffic information on top of that, so now you know what happens along the route and actually can change your course based on that information.

  That's a premium service that's built into a package that you can get from Acura, on the Acura RL and, and it's very exciting.

  And we have other services in that vein that we're working on with the car companies because we have this great infrastructure where we can deliver a lot of data, you know, one way down to a car, and we're working with those companies on these "telematic solutions," that are proving to be very efficient and that they have been highlighting a lot of their advertising.

• TERENCE SMITH:

  Do you then have, I gather, unused bandwidth that you can —

• HUGH PANERO:

  Well, we have unused bandwidth at different times of the evening, during the day, doing data that requires not as much bandwidth as doing a classical channel or a video channel.

  Right now, on the radios that we sell, we actually display up to 20 stock quotes and sports scores.

  So we have become a very interesting mobile communication, entertainment, data service, that is just going to become more interesting, and the radios that we just came out with, the MyFI, which is the first portable device, actually has memory in it.

  So now you can take XM into places that you couldn't take it before. Because it's on your belt you can go into a subway, on an airplane, listen to content that's been recorded, which you can record up to five hours, and it becomes a very exciting portable product.

• TERENCE SMITH:

  It's fascinating. A final thought. You were in on the ground floor of this, present at the creation.

  Has it already surprised you, where it's gone?

• HUGH PANERO:

  Well, I mean, we probably spoke five, six years ago when I first came here, and I think, on reflection, I always had a belief that the concept would work and that the people would want a service like this and be willing to pay a price for it very similar to cable television.

  The journey that has occurred is something that I could never have imagined with regards to September 11th, changes in the stock market, or the crashing of the market, personal issues that have occurred in my life, and the excitement that how quickly it has ramped up, and the knowledge that I have of all these different businesses — consumer electronics, the car industry, manufacturing — which are fascinating businesses.

  At the end of the day, I figure we're all going to be here. Actually, I think we've reached a certain level of awareness and excitement that has occurred faster than I actually thought it would.

  But with all these businesses, you know, you got to know what the end point is, but you've got to enjoy the journey. If you don't enjoy the journey, you shouldn't be involved.

• TERENCE SMITH:

  We've certainly heard speculation that in the end, one satellite radio service is going to buy the other. Is it going to happen?

• HUGH PANERO:

  Oh, well, there have been some rumors and, you know, we don't really comment on rumors and speculation. However, what I can say is that I have actually never met Mel Karmazin, (but) I look forward to it because we're building a very interesting business as competitors together. Actually — the media outlet that reported some rumor to that effect — that there was some conversation going on — is the same media outlet that reported that Richard Gephardt was going to be John Kerry's running mate.

  All I could say is that we are focused very much on building our business and we project that we're going to be at 5.5 million subscribers by the end of 2005, and have over 20 million by 2010. We're marching to those goals.

• TERENCE SMITH:

  So you're competing, not trying to swallow each other?

• HUGH PANERO:

  We are competing, we are competing. It's a very interesting business in a duopoly like this, where at times you're both spokesman for satellite radio and you want to build the category and you really need two companies to do that, to build awareness. Other times, we are fighting tooth and nail to get a subscriber.

  Other times, from a regulatory standpoint, we are arm in arm fighting against a common opponent which maybe is the NAB [National Association of Broadcasters].

  We're battling to get car companies to pay attention to one company or the other. So it's an interesting business, but we are fierce competitors and I think we basically demonstrate that every day at retail and every day at car companies, but I think it's a big business and I think both companies can be successful.

• TERENCE SMITH:

  Mel Karmazin went through a bit of a conversion himself.

• HUGH PANERO:

  Clearly a conversion. Obviously Mel Karmazin was somebody who, very successful businessman who, six or seven months ago would follow me on road shows in his role at Viacom, where investors would be hearing a satellite radio pitch from either me or even Sirius at the time, and the radio guys would come in at a time he was running Viacom and he would just trash the whole category.

  So I'm just very happy that he's seen the light and we've created this great platform for him to find all this gainful employment. We welcome him to the category and hopefully both companies will be able to grow the whole business much faster together than it has been in the past.